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Sunday, August 14, 2011

India is planning to set up its own aid agency to distribute its own US$11 billion over the next five to seven years, according to The Economist. South-South aid is increasing and the aid dynamics is changing. Here is a post on South-South aid to Nepal (India being the largest donor).

For decades, India was the world’s biggest aid recipient. Now, it is likely to join Brazil, Russia and China in using aid to win friends and influence people abroad. The rules of aid are being turned inside-out and long-standing donors—governments and non-governmental organisations (NGOs) alike—must change, too.

[…] But India’s proposal shows that donors, like generals, are still fighting the last war. The old binary division of the world—between rich countries which give aid and poor ones which get it—is gone. Fewer countries are poor and eligible for cheap loans. Two-thirds of the world’s poorest people—those with less than $1.25 a day—live in middle-income countries, such as India, which increasingly are donors as well as recipients.

[…] As India also shows, middle-income countries no longer need financial transfers to help their own people. That was clear before: India has a space programme and $300 billion of foreign reserves. A new aid agency would ram the point home. Once, Westerners could say they needed to help India’s poor because India’s own government could not afford to. Not now.

Now, the Southern and the Northern donors should focus on their comparative advantage—the former in infrastructure and the latter in promoting good governance.

In this new world the justification for aid and the behaviour of donors must change. For India and others, it is far from clear why the government should send aid abroad when it has so many poor people at home. No doubt, aid will be defended as a boost to global influence. The risk for India is that, just like the West did in the 1960s, it will pour money into grand projects which fail—and encourage bad government.

For Westerners, justifying aid will be harder. But there is a reason to give: like trade, aid benefits from specialisation and comparative advantage. Emerging countries, with recent experience to draw upon, might do a better job of infrastructure spending. The West should focus more on policies and good governance (something many poorer Indian states are crying out for). There is a new world of aid but over a billion people remain poor; they still need help, even if some of them live in countries that now give aid as well as get it.

This is published in Republica, August 13, 2011, p.6. It discusses the pros and cons of remittances at household and national level in Nepal. It is based on two key surveys, namely Nepal Living Standard Survey III and Nepal Migration Survey. Read my earlier posts on remittances here and here.

Remittances account for 23 percent of the total value of goods and services produced in the country (generally termed as gross domestic product—GDP), according to estimates by World Bank economists. Remittances have been the backbone of our economy, especially after 2000 when remittance inflows started to skyrocket. So far the extent of its impact has been discussed based on anecdotes and observations. Lately, its true reach and impact at household and national levels are estimated in two forthcoming studies based on surveys, namely Nepal Living Standard Survey (NLSS) III and Nepal Migration Survey (NMS) 2009. The findings are startling, both positively and negatively, and they indicate the laxity of our politicians and policymakers in enacting the needed reforms for structural transformation.

First, let us start with NLSS III, whose full version is not released yet, and the blessing of remitters in helping to bring about the positive changes. Over the last six years absolute poverty declined to 13 percent of total population, down from 31.5 percent in 2003/04—an incredible 18 percentage point decline in poverty, or three percentage point decline each year. Nominal average household income and nominal average per capita income have increased by 153 percent and 175 percent respectively. Furthermore, nominal per capita consumption of the poorest households has increased by 165 percent while that of richest households by 66 percent only. Also, average household income of the poorest and richest 20 percent households has increased by 297 percent and 133 percent respectively. It has contributed to a decline in income inequality, measured by Gini coefficient, to 0.35 from 0.41 recorded in the second NLSS. The average daily wage in agriculture sector has increased by 127 percent between the two surveys, but that of non-agriculture sector by 98 percent only. Access to other facilities has also improved.

What has led to such an astounding positive results at the household level at a time when the major macroeconomic variables are either stagnating or deteriorating amidst increasing political uncertainty? The only convincing factor you can think of is remittance, which has increased by 327 percent (574 percent if you use NLSS data) between 2004 and 2010. These positive changes have not come about due to hard work of our policymakers and political leaders. They are due to high remittance inflows directly to households sent by hardworking Nepalese sweating and risking their lives in various employment destinations abroad.

The massive jump in average household income—particularly that of the poorest households which make up the most of the 55.8 percent of households that receive remittances—has nothing to do with the policies that were implemented in the last six years. So much resources and efforts have been invested to reduce poverty but its effect seems to have faltered in the face of the impact of remittance at the household level. In reality, the NLSS III results indicate a policy failure and a resounding victory of remitters in reducing income poverty and inequality directly and most efficiently than any initiative carried out in the past six years. Now, some might argue that access to roads, services (education and health) and wage increase might have led to that. But, the impact of these factors is not as fast and as deep as that of remittances, which directly bumped up household income. Also, since these factors have not contributed to boosting economic growth, it appears poverty has decreased without a convincing growth rate. May be it is about time to change policy strategies to fight poverty in Nepal.

Unfortunately, the positive changes in the short run have masked a dangerous trend at policy and macroeconomy levels. First, rising remittances and increase in income of the poorest lot have made politicians and policymakers, especially at Ministry of Finance (MoF) and National Planning Commission (NPC), complacent about the automatic changes at the household level. They should not claim credit for the positive changes outlined above because no substantial policy level initiative has been carried out over the last six years to reduce poverty expect for the customary efforts through Poverty Alleviation Fund (PAF). The only credit they should take is for their contribution to the exodus of remitters to destination abroad because of their failure to create enough employment opportunities at home. Meanwhile, equal blame goes to the insensitive, visionless, and selfish political leaders who have created a mess that has led to closure of factories, capital flight, and loss of employment and entrepreneurial opportunities, triggering migration of youths.

Second, the MoF and the NPC have been increasing the size of fiscal budget without any substantial impact on the economy, where still 76.3 percent of households depend on agriculture. In the last six years, the economy saw economic growth above 5 percent in 2007/08 only. This was not the result of any miraculous policy intervention, but due to blessing of monsoon that boosted agriculture production. The laxity in enacting real reforms has triggered consumption binge (only 2 percent of household remittance is spent on capital formation). Worse, since domestic production is insufficient to satisfy domestic demand, we are forced to import goods and services, resulting in ballooning trade deficit. Now, the increase in labor costs will further increase cost of production and make our products even more uncompetitive, forcing us to import even more. Note that the exodus of workers has created a shortage of labor and an increase of average daily wage in agriculture sector by 127 percent and that of non-agriculture by 98 percent between the two surveys.

There is even more dangerous trend directly attributed to remittances, as revealed by NMS 2009, at the macroeconomy level: symptoms of Dutch disease in the Nepalese economy. Simply, a Dutch disease occurs when an economy depends on one sector so much that it leads to decline in manufacturing sector. In Nepal, increasing remittances at the household level have led to high consumption demand, high imports, and appreciation of real exchange rate, resulting in the erosion of manufacturing sector and its competitiveness.

Allow me to simplify it further. As income increases due to remittance inflows, aggregate demand and spending goes up as well. This puts pressure on nontradables in the domestic market, leading to rise in demand and output. But, due to high demand wages also tend to increase in all the sectors, both tradable and nontradable. It increases cost of production throughout the economy, leading to squeezing of profits in the nonresource tradables sector (manufacturing), whose prices are pretty much fixed in the international market (prices of nontradables are fixed in the domestic market). This means customers will look for substitutes at cheaper price, thus increasing imports and reducing domestically produced nonresource tradables. This gradually erodes the existence of the whole manufacturing sector. Meanwhile, since incomes are higher from migration, capital and labor are attracted to this sector from other sectors of the economy, resulting in reduced output and labor supply in the latter ones. As mentioned above and as corroborated by both NLSS III and NMS, we are seeing all of these undesirable changes happening in the Nepali economy.

While we applaud the findings of NLSS III let us also not forget that the positive results, which might be short-lived, are primarily due to the remitters assiduously working and sweating outside the country, and not due to policy interventions by MoF, NPC and the political leaders. Kudos to the remitters. Congratulations to all for the positive results. Good luck to policymakers and politicians to manage the messy fallout from the overdependence on remittances in the days ahead!

About

Formerly, economics officer at Asian Development Bank, Nepal Resident Mission. Worked as a researcher at SAWTEE, Kathmandu. Also, worked as a consultant for Ministry of Commerce & Supplies, Government of Nepal; FAO; UNDP, GIZ-CIM, and ADB among others. I was an op-ed columnist for Republica between December 2008 – June 2012. I also worked as a Junior Fellow for Trade, Equity & Development program at Carnegie Endowment for International Peace, Washington, D.C .